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PRA Probes Broker Facilities

The Prudential Regulation Authority (NYSE:PRA) is investigating broker facilities in one of two interconnected reviews launched amid pleas for help from carriers in tackling mounting acquisition costs, The Insurance Insider has learned.

The decision to study facilitisation represents a marked shift in the regulator's stance, with the PRA previously making clear that it did not consider facilities and the associated increase in broker remuneration a matter for prudential regulation.

UK regulators working on something dubbed the Financial Risk Framework (NYSE:FRF) review have asked some London market carriers for copies of the agreements they have struck with brokers over facilities, sources said.

Two sources said the PRA plans to quiz more than 20 Lloyd's managing agents, and that meetings with CEOs and chief underwriting officers had already begun.

The PRA is examining facilities written by both managing agents and the company market.

The exercise could usher in reform, but a consultation would have to be conducted before any changes could be implemented.

It is possible that the outcome of the probe could be restricted to a "Dear CEO" letter.

The PRA's work will feed into a separate Financial Conduct Authority (NASDAQ:FCA) review of value in the insurance distribution chain and a study on the wholesale insurance market.

The FCA's work is in its early stages, but more than one underwriting executive indicated that they expected facilities and rising acquisition costs to be one of the areas of focus.

The FCA previously conducted a review of facilities in 2013 after the issue was flagged following the Aon-Berkshire Hathaway sidecar, but it is not clear that any regulatory action resulted from the work.

Taken alongside the FCA's ongoing investigation of aviation teams at five major brokers, the two regulators' actions appear to increase regulatory risks for brokers more than a decade after the then New York Attorney General Eliot Spitzer waged war on contingent commissions across the Atlantic.

The FRF review follows searing criticism of certain broker practices from Chubb CEO Evan Greenberg and Sompo International CEO John Charman earlier this year.

It is further understood that multiple carrier executives have privately solicited a regulatory investigation into the practice - some orally and others in writing.

Data from this publication shows the Lloyd's acquisition cost ratio swelled from 27.5 percent in 2013 to 32.4 percent in 2016.

The expense ratio in 2016 stood at 40.6 percent, meaning almost 41 pence in the pound disappeared in the delivery of the product even before any claims were paid.

Carrier criticism has focused on two points. Firstly, that the ramping up of acquisition costs at the same time as rates have come under sharp pressure has severely compressed underwriting margins.

And secondly, that facilitisation only superficially benefits insureds, given the scope for conflicts of interest to compromise client outcomes and for diminished underwriting profitability to trigger an accelerated hardening of the market.

Rising acquisition costs in the Lloyd's market have eroded almost 5 percentage points of underwriting margin since 2013. Stripping out this impact could have brought the market's combined ratio in at 93.0 percent for 2016, rather than the 97.9 percent reported.

If acquisition costs had remained flat since 2013 this would have added £1.11bn ($1.43bn) to underwriting profits - more than trebling the result the market posted in March.

To illustrate the second point, insurers call attention to both to panel-style facilities and the data services sold to carriers either on a standalone basis or as a non-negotiable part of a facility deal.

Privately some of them argue that panel facilities can incentivise brokers to place business with certain markets based on the way they are remunerated, creating conflicts of interest that are difficult to successfully manage.

Multiple CEOs of Lloyd's managing agents have also told this publication for a period of years that they feel the services bundled into these deals or sold separately are not commensurate with the fees charged by the brokers.

None of the big-three brokers were willing to comment for this piece. However, their counter arguments are well known.

The brokers have argued facilitisation of business to create more streamlined placement mechanisms and consolidate slips is a key plank of market modernisation.

In addition, they argue that the underwriting of portfolios rather than individual risks is now possible because of the massive investment in data analytics that the big three have led over the last five years.

But the brokers' central argument for facilitisation is that it improves client outcomes, with pre-pledged capacity levering down prices and panel structures intensifying competition.

Brokers also stress that current facilities have strong controls around remuneration to ensure alignment, with all compensation arrangements clearly disclosed to clients and insureds given the final choice on which capacity is used for their placements.

Alongside the FRF review, the PRA is conducting a thematic review of insurance underwriting and pricing.

The PRA will probably conclude both the FRF review and the underwriting and pricing review towards the end of the year, and may or may not publicise its findings.

For its part, the FCA said in April that its study of the wholesale insurance market would "assess how effectively competition is working in these markets, including how firms ensure practices do not create market integrity and conduct risks".

The most high-profile facilities in the London market include Aon Client Treaty, the broker's all-class 20 percent follow-form facility.

Willis Global 360, a mosaic of 20 percent follow-form facilities across a range of lines, is also among the most prominent structures.

The PRA and the FCA declined to comment.

Lloyd's Market Association CEO David Gittings said: "This is the first time in my experience I can recall the statutory regulators having a look at the wholesale insurance market."

The full version of this article first appeared in the latest issue of The Insurance Insider, which is available for subscribers to read here